Are FHA Loans a Good Choice for First-Time Buyers in California?

Many first-time buyers in California use the FHA loan program to purchase a home. This government-backed mortgage program allows eligible borrowers to finance the entire purchase price, avoiding the need for a down payment altogether.

Here are five things to know about FHA loans right from the start:

1. They’re not limited to first-time buyers but can be well suited for this group.
2. They require a down payment of at least 3.5% of the purchase price.
3. They require a credit score of 580 or higher for the above down payment.
4. They’re generally easier to qualify for, compared to conventional loans.
5. They have size limits that vary based on the county in which you reside.

At a glance: FHA loans can be a good financing option for some borrowers, especially those who have had credit issues in the past and/or can’t afford a large down payment. But they also have a downside in the form of long-term mortgage insurance.

The FHA Loan Program Explained

The FHA loan program has been serving borrowers in the United States since the 1930s. It was created in response to the Great Depression. Today, this program serves the same primary purpose as when it was first created. It supports homeownership by making home loans more affordable for a larger group of Americans.

Last year alone, more than 100,000 California home buyers used FHA-insured mortgage loans to purchase a home. The majority of those were first-time buyers.

But what is an FHA loan, exactly?

FHA loans are insured by the government via the Federal Housing Administration. This insurance protects mortgage lenders from financial losses related to borrower default. But it benefits home buyers as well, by allowing for more flexible qualification criteria.

A conventional home loan, on the other hand, does not receive government insurance backing. Conventional is the most common type of mortgage financing in California, while FHA loans come in second in terms of volume.

Advantages for First-Time Home Buyers

FHA-insured mortgages are not limited to first-time home buyers. But they’re often well-suited for such borrowers. Here are some of the reasons why:

1. A low down payment of just 3.5%

In an expensive state like California, first-time buyers often lack the funds needed to make a large down payment. So the FHA’s minimum down payment requirement of 3.5% can be very appealing to these borrowers.

A conventional loan, on the other hand, might require a down payment of 5% or higher. (Though some conventional products allow for just 3% down.)

But in order to qualify for the minimum down payment on an FHA loan, first-time home buyers need to have a credit score of 580 or higher. That’s one of the minimum requirements for this program.

2. Down payment gift money is allowed

The FHA allows borrowers to use a variety of sources for their down payment funds. This includes all of the things you would expect, like checking and savings, retirement accounts, grants, etc.

But there’s also a lesser-known funding source that can help first-time buyers in California come up with the money needed for a down payment. It’s called gift money.

This is a pretty big deal, especially in a state like California where the median home price is currently approaching $800,000. At that price point, even the minimum (3.5%) down payment for an FHA loan would amount to roughly $28,000.

A lot of first-time buyers in California don’t have that much money in the bank. But they might have a parent or other relative who is willing to chip in for the upfront expense on a home purchase. Fortunately, the FHA loan program allows for such contributions.

3. More flexible credit requirements

It’s generally easier to qualify for an FHA mortgage than a conventional loan, in terms of credit scores and debt ratios. That’s because of the government backing mentioned earlier.

Here are the minimum credit score requirements:

• According to official HUD guidelines, first-time buyers in California who want to use an FHA loan need a credit score of 500 or higher. That’s for basic program eligibility.
• If you want to use the minimum 3.5% down payment option mentioned above, you’ll need a credit score of 580 or higher.

Conventional loans often require a higher score. Many lenders set the bar at 620, while some require a score of 640 or higher for a standard fixed-rate mortgage. This makes the FHA program a more flexible option for borrowers with lower scores.

Mortgage Insurance Required for All Borrowers

Some first-time buyers in California rely on the FHA program for its low down payment and flexible qualification criteria. But there are some potential downsides to consider as well, and mortgage insurance tops the list.

First-time home buyers who use an FHA loan to buy a house have to pay for mortgage insurance. We talked about the reasons for this earlier. This program works like one big insurance fund, with both the lender and borrower benefitting in different ways.

First-time buyers actually have to pay two different insurance premiums when using an FHA-insured mortgage loan:

• There’s an upfront premium that equals 1.75% of the loan amount. This one-time expense can be paid upfront, as the name suggests, or rolled into the loan.
• There’s also an annual (recurring) mortgage insurance premium that equals 0.55% of the loan amount for most borrowers. But the exact amount can vary depending on the mortgage term and the amount of money you put down.

With a conventional home loan, on the other hand, mortgage insurance requirements are determined by the down payment and loan-to-value (LTV) ratio. If a home buyer makes a large enough down payment to keep the LTV below 80%, they can avoid mortgage insurance.

But with an FHA loan, mortgage insurance is required for all first-time buyers in California, regardless of how much they put down. It’s built into the program.

How the Home Buying Process Works

The process of buying a home with an FHA loan can vary from one first-time buyer to the next. But it usually follows a structured and logical sequence that includes the following steps.

• Budgeting: Figure out how much you can comfortably spend on a house each month, taking into account your income, expenses, and savings.
• Pre-Approval: Talk to a mortgage lender (like us) to get pre-approved for an FHA loan. This will tell you how much money you can borrow, so you can shop accordingly.
• House Hunting: Start looking for homes that fit your budget and needs. Try to focus on well-maintained homes that can pass the FHA property review process.
• Make an Offer: When you find a home you love, make an offer on it. Consider adding contingencies to your offer, such as the home passing an inspection.
• Home Appraisal: The lender will order an appraisal to make sure the property is worth the price you’re paying. The FHA requires this for all purchase loans.
• Home Inspection: You can choose to get a home inspection to check for any problems with the property. This step is optional but recommended.
• Underwriting: The lender will review your loan application and all of the documents you’ve provided to make sure they meet applicable guidelines.
• Closing: If your loan is approved, you’ll sign the final paperwork and get the keys to your new place!

For the most part, the home buying process works the same whether you use an FHA or a conventional mortgage loan. The main difference has to do with the government mortgage insurance that’s required by the Federal Housing Administration.

Conclusion: Good for Some, But Not for All

FHA loans are not limited to first-time home buyers in California. Anyone who meets the minimum requirements for the program can obtain an FHA-insured mortgage, even if they’ve owned a home in the past.

But this program is particularly well suited for first-time buyers, and for a number of reasons. It allows you to make a relatively low down payment when buying your first home in California, and the funds can be gifted from someone else. That’s a big benefit for first-time buyers.

Additionally, FHA is one of the easiest mortgage programs to qualify for. The federal government insures these loans, giving lenders an added layer of protection. As a result, the eligibility criteria for borrowers tend to be more lenient when compared to a conventional mortgage.

Let’s talk mortgages. Bridgepoint Funding can help you decide which financing option is right for you, based on your current financial situation and long-term goals. Our broker business model gives us access to multiple lenders and a wide variety of loan options.